Global ETF Profits: The Easy and Safe Way to Own a Diversified Global Portfolio

Exchange-traded funds (ETFs) are the future. There is simply no way you can touch the new global economy’s enormous and far-flung profits without the power of ETFs.

 – Benjamin Shepherd, Global ETF Profits

Exchange-traded funds (ETFs) are taking the investment world by storm.  In a March 2008 joint survey of investment professionals conducted by State Street Global Advisors and the Wharton School of Business, 67% characterized exchange-traded funds (ETFs) as “the most innovative investment vehicle of the last two decades” and 60% stated that ETFs had “fundamentally changed the way they constructed investment portfolios.” 

The actions of investment professionals speak just as loudly as their words; ETFs are the fastest growing segment of the mutual fund industry. According to a June 2009 report by Deloitte, since 2001 U.S.-based ETF assets have grown at an astounding compounded rate of 44% per year!  The global ETF business has grown into a more than $1 trillion industry.  Although still smaller than the $19 trillion in traditional mutual fund assets, ETFs may one day surpass mutual funds given their inherent advantages.

ETFs Offer Diversification

What is it about ETFs that make them so desirable? First and foremost is instant diversification. Researching individual stocks and bonds is time-consuming and the effort doesn’t even guarantee outperformance. Furthermore, there’s always a risk that an individual stock will blow up on you. In contrast, all it takes is one commission to buy one ETF that represents tens if not hundreds of stocks and you’re done with an industry sector or asset class. Easy, inexpensive, and safe. Go back and read part 4 of my series on asset allocation. It shows you how easy it is to construct a model portfolio with complete diversification over all the important asset classes (e.g., stocks, bonds, real estate, commodities, industry sectors, foreign markets) using just ETFs.

ETF Advantages over Mutual Funds

While both ETFs and traditional mutual funds offer investors the benefit of “instant diversification,” there are at least six advantages ETFs have over traditional mutual funds:

Lower Management Fees. According to Deloitte, the average management fee for ETFs is 0.41% versus 1.47% for traditional equity mutual funds. Most of this difference is due to the fact that ETFs are primarily index funds whereas traditional mutual funds are primarily actively-managed funds. Actively-managed funds incur additional costs to pay the salaries of fundamental analysts, researchers, traders, and other back-office personnel. By contrast, an ETF that tracks an index requires far fewer salaried personnel.

To be sure, since ETFs are traded on a stock exchange, you need to pay a commission to buy and sell them, whereas you can buy no-load mutual funds commission-free. But keep in mind two things: (1) many traditional mutual funds are “load” funds that can cost you up to a 5.75% sales charge); and (2) Fidelity, Schwab, and Vanguard offer a limited number of ETFs commission-free. Furthermore, for buy-and-hold investors, the lower annual management fees of ETFs more than compensate for the up-front broker commissions you must pay, especially if you use an online discount broker.

In addition to the cost disadvantage of traditional mutual funds, a 2009 study found that the vast majority of actively-managed mutual funds (78%) underperform the indices to which they are benchmarked!  Higher costs and worse performance is quite a nasty combination. One commentator summed up the findings best when he concluded recently: “as a group, active management is still underperforming passive management in all categories and over nearly all time periods.”

Transparency. ETFs are required to disclose their fund holdings on a daily basis, whereas traditional mutual funds are “black boxes” that only disclose their holdings quarterly.

Tax Efficiency. When an individual investor sells an ETF, it occurs on a stock exchange with some third-party buyer. The transaction has no effect on the ETF manager. An institutional investor can demand that the ETF manager redeem ETF shares for the underlying holdings, but this is an “in-kind” exchange that is tax-free. In contrast, when a shareholder in a traditional mutual fund wants to cash out, he is transacting directly with the fund manager who oftentimes must sell portfolio holdings to pay for the redemption. The sale of portfolio holdings in exchange for cash is a taxable event.

Note: inverse and leveraged ETFs that trade futures can incur substantial taxes, so I would avoid those.

Trading Flexibility. ETFs trade throughout the day whereas mutual funds can be purchased only once at a fixed price at the end of the day. ETFs can be shorted; mutual funds can’t. And if you want a levered bet on an ETF, you can trade options on the ETF. Mutual funds don’t have options.

Minimum Purchase. The minimum purchase for an ETF is one share of stock, which is almost always affordable (The highest-priced ETF I could find is ETFS Physical Platinum Shares (NYSE: PPLT) at a per-share price of $154). In contrast, mutual funds can have minimum initial purchases in the thousands of dollars. For example, Bruce Berkowitz’ excellent Fairholme Fund (FAIRX) isn’t so excellent when you realize that it has a $10,000 minimum.

Commodities. Speaking of platinum, I couldn’t find a traditional mutual fund that provides direct exposure to it. And this is true of other commodities as well. ETFs provide an investor with commodities exposure you simply can’t find in the traditional mutual fund space. And as I discussed in part 2 of my asset allocation series, commodities have an extremely low correlation with stocks, so they are a critical component of a well-diversified portfolio.

ETFs are Good for Investors, Not so Good for Brokers

Given all of these ETF advantages, I was shocked to read in the State Street/Wharton survey that a majority (53%) of investment professionals consider themselves only “light” users of ETFs, employing them in less than a quarter of their portfolios.  What gives?  Part of it could be ignorance, but I think a large part has to do with the compensation structure of most financial advisors. ETFs are corruption-proof. There is only one class of them and their management expenses are super low. ETFs do not share any revenue with financial advisors.

In contrast, load mutual funds (the ones sold by brokers and many financial advisors) have many different share classes (e.g., A, B, C). Each load class charges investors fees used to compensate the recommending advisor. In essence, financial advisors are bribed to recommend load funds to their clients. It’s a national disgrace and one reason I wrote an article urging investors to ditch their broker.   

Another reason that ETFs have seen slow adoption involves retirement plans (401k and IRA). As I stated earlier, because ETFs trade on an exchange, investors must pay a commission each time they buy and sell them. With retirement accounts, investors are making monthly investments and ETF commissions can really add up and detract from returns. The commission-free programs of Fidelity, Schwab, and Vanguard are a first step in opening up the retirement plan market to ETFs.

Not All ETFs are Created Equal

For the self-directed buy-and-hold investor not trapped by a financial advisor’s conflict of interest, ETFs are an excellent choice. But understanding the general advantages of ETFs is only half of the battle. The question remains which industry sectors and which specific ETFs within those sectors are most likely to become the top ETFs for 2010 and beyond.  Not every ETF is inexpensive or well-diversified, and some track strange, custom-built indices that include unexpected (and unwanted) securities. You need to know the difference between the ETFs that should be avoided and which are the true gems that must be bought.

Global ETF Profits is Your Best Source of Independent Investment Advice

Receiving trusted advice to help guide you through the thicket of ETF choices is crucial to a well-performing portfolio. That’s why I’m so impressed with the ETF investment advisory service managed by KCI’s own Ben Shepherd and Yiannis Mostrous. These two gentlemen know what they are talking about. Ben is a mutual fund expert with many years of experience editing the Louis Rukeyser’s Mutual Funds newsletter, and Yiannis is a native of Athens, Greece with a unique understanding of foreign markets. The combination of these two skill sets is ideal for advising subscribers on constructing a global and diversified ETF portfolio. Unlike brokers, Ben and Yiannis have no conflicts of interest; their only incentive is to make you as wealthy as possible. When I interviewed Ben back in March at the launch of Global ETF Profits, he had this to say about Yiannis:

Yiannis never fails to amaze me with his knowledge of Asia and the emerging markets, plus he’s really proven himself to be a prescient trend spotter on a global scale. The returns he’s generated at Silk Road Investor really speak for themselves. We believe the combination of his global investment acumen and my fund expertise will allow us to really outperform the markets by spotting the emerging themes rather than just riding out the stories that everyone’s already piled into.

Three ETF Portfolios

The service has three separate portfolios: (1) Growth; (2) Income and Hedges; and (3) Short-Term Opportunities. They can be followed together or separately. A long-term investor who wants a fully diversified global portfolio can buy all of the recommendations in the growth and income portfolios. A trader can focus only on the short-term opportunities portfolio. Beginning investors just getting started can purchase one or two ETFs and build up from there. Which ones? What’s great about Global ETF Profits is that Ben and Yiannis list their absolute favorite ETFs at the top of each portfolio list in descending order, so you always know exactly which ETFs to buy first.

Instantaneous Email Alerts

And if anything changes between monthly issues, you will receive a lightning fast email alert explaining the situation and what action you should take now. In addition, virtually each month the advisors tape a video on the Global ETF Profits website in which they explain an investment topic of interest. It makes me feel good to see and hear from my financial advisor, as opposed to just reading his articles. Global ETF Profits is truly like having a personal ETF advisor looking after you on a daily basis. 

Risk-Free Trial for 90 Days

I can’t disclose their favorite global growth sector, but I have been authorized to give you their second favorite: oil equipment. To find out which specific ETF they recommend in oil equipment, as well as what beats out oil equipment as their absolute favorite industry sector, give Global ETF Profits a try risk free for 90 days. If you are not completely satisfied, you may cancel for a full refund.